China in Transition

Stepping up Efforts toward Renminbi Internationalization

Chi Hung KWAN
Consulting Fellow, RIETI

As the U.S.-originated financial crisis worsens, confidence in the U.S. dollar has begun to erode and momentum is building for reforming the international monetary system. Meanwhile, China has become concerned that its enormous foreign reserves, primarily invested in U.S. Treasury securities, are exposed to significant risk. Chinese authorities are faced with a pressing need to revise their investment strategy. Against this backdrop, China is stepping up efforts to find ways to "internationalize" its currency.

"Internationalization of the renminbi" refers to increasing the extent of its use in China's cross-border transactions and in overseas transactions in general, and increasing the volume of renminbi-denominated assets held by nonresidents. More specifically, it refers to expanding the role of the renminbi in the international monetary system and increasing the weight of the renminbi in current account transactions, capital account transactions, and foreign reserve holdings.(note 1)

Expanding the use of the renminbi in neighboring economies

Although China's endeavor to internationalize the renminbi has just begun, some progress is already visible in transactions with its neighboring economies.

First, the renminbi is being widely used in trade and other current account transactions with Vietnam, Laos, Myanmar, the Central Asian states, Russia, and so forth. Also, with more mainland Chinese tourists visiting Hong Kong and Macau, the renminbi is now being circulated alongside the respective local currencies. Given this state of affairs, the Standing Committee of the State Council decided at its meeting on December 24, 2008, to launch renminbi settlement trials for goods traded between the Guangdong-Pearl River Delta area and Hong Kong-Macau, and between the Guangxi-Yunnan region and the Association of Southeast Asian Nations (ASEAN). China also has signed agreements with eight neighboring countries, including Russia, Mongolia, Vietnam, and Myanmar, to allow the settlement of bilateral trade payments in the renminbi.

Meanwhile, with respect to capital transactions China has promulgated provisional rules governing the issuance of renminbi-denominated bonds by international development institutions, thereby allowing nonresidents to issue in Chinese markets so-called panda bonds, which are the Chinese equivalent of Japan's samurai bonds.

In October 2005, the Asian Development Bank (ADB) and the International Finance Corp. (IFC) issued 10-year renminbi-denominated bonds worth one billion renminbi (¥13.2 billion) and 1.13 billion renminbi, respectively. The IFC launched its second panda bond issue worth 870 million renminbi in November 2006. At the moment, eligible nonresident issuers are limited to international development institutions. But it is expected that the scope of eligibility will be expanded to include foreign companies.

Professor Yu Yongding, director-general of the Institute of World Economics and Politics, Chinese Academy of Social Sciences (CASS), calls for expanding the panda bond market so that Chinese investors can invest in renminbi-denominated foreign bonds.(note 2) The panda bond market would grow tremendously if the scope of eligible issuers was expanded beyond foreign companies and financial institutions to include foreign governments (most importantly, the U.S. government).

Furthermore, in regard to its management of foreign exchange reserves, since the outbreak of the global financial crisis the People's Bank of China (PBOC) has entered into a series of bilateral currency swap agreements whereby the PBOC and other central banks have agreed to exchange the renminbi (not the U.S. dollar) with the respective counterparty currencies. The first such deal was struck with South Korea on December 12, 2008, with the Chinese and South Korean central banks agreeing to exchange a maximum of 180 billion renminbi for 38 trillion won (approximately $28 billion). The two countries are also discussing the degree to which they would include the other party's currency in their respective foreign exchange reserves.

China also recently concluded a 200 billion renminbi currency swap agreement with Hong Kong on January 20, 2009, followed by another agreement worth more than 80 billion renminbi with Malaysia on February 8, 2009. These inter-central bank arrangements are expected to expand China's trade with its respective partners by providing renminbi-denominated funds to counterparty countries and regions.

Hong Kong is aiming to become an offshore renminbi trading center

By catching the wave of renminbi internationalization, Hong Kong aims to become an offshore renminbi trading center and the Chinese government is giving full support to the move. In February 2004, banks in Hong Kong formally began accepting renminbi deposits. As of the end of 2008, 39 banks were handling renminbi business and the total renminbi deposits outstanding amounted to 56.1 billion renminbi, according to the Hong Kong Monetary Authority.

Meanwhile on June 8, 2007, the Chinese authorities - i.e., the PBOC and the National Development and Reform Commission - announced provisional rules governing the issuance of renminbi-denominated bonds by domestic financial institutions in the Hong Kong Special Administrative Region to allow mainland Chinese policy and commercial banks to issue renminbi-denominated bonds there. One month later in July 2007, the China Development Bank (CDB) became the first mainland Chinese financial institution to launch renminbi-denominated bonds in Hong Kong.

Debt issuance in Hong Kong enables mainland Chinese enterprises to raise funds at lower costs than in the mainland market, while allowing Hong Kong investors to earn higher rates of return than on renminbi-denominated bank deposits. Subsequently, one Chinese financial institution after another including the Export-Import Bank of China, the Bank of China, and the Bank of Communications have issued renminbi bonds in Hong Kong. At the moment there is a ceiling on the amount of renminbi bonds that can be issued per year, with eligibility limited to domestic financial institutions. Only investors with renminbi-denominated bank accounts in Hong Kong are permitted to purchase the bonds, but the Hong Kong authorities are calling for easing these conditions in a bid to expand the renminbi bond market.(note 3)

Furthermore, the aforementioned China-Hong Kong currency swap agreement serves as an emergency liquidity support mechanism to provide renminbi funds to Hong Kong banks operating in mainland China and Hong Kong dollar funds to mainland Chinese banks operating in Hong Kong.

Lastly, when "Several Opinions of the General Office of the State Council on Providing Financing Support for Economic Development" was issued on December 8, 2008, the 30-article opinion set out policies clearly encouraging the issuance of renminbi bonds in the Hong Kong market by Hong Kong-based enterprises and financial institutions operating in mainland China (Article 13) and supporting the development of renminbi business in Hong Kong (Article 22). These policies were reconfirmed in Premier Wen Jiabao's report on government activities delivered to the National People's Congress in March 2009.

Capital controls pose the biggest bottleneck

Renminbi internationalization is thus ready to move forward. However, a number of issues still need to be resolved because further progress hinges not only on the plan's expediency for China, but also on the attractiveness of the renminbi as an international currency for other countries.

For China, the greatest advantage to renminbi internationalization is reduced foreign exchange risk for Chinese enterprises. The renminbi's use in contracts and invoices for international trade and settlements would eliminate the risk of foreign exchange fluctuations for Chinese exporters and importers, thereby enabling them to save on transactions costs including hedges using futures. Furthermore, enabling Chinese investors to hold renminbi-denominated foreign assets would eliminate the risk of capital losses resulting from a weaker U.S. dollar. These measures would surely facilitate international trade and capital transactions.

The renminbi's internationalization will also enhance the international competitiveness of Chinese financial institutions. Chinese banks and securities companies would have competitive advantages over their U.S. and European counterparts in renminbi business dealings - including loans, trade finance, and the issuance of renminbi-denominated foreign bonds - and be able to earn higher returns without bearing the cost of foreign-exchange related risks. As a result, both Shanghai and Hong Kong would be able to improve their standing as international financial centers.

Furthermore, when the renminbi gains wide acceptance as an international currency, China will enjoy the additional benefit of seigniorage, i.e., the difference between the face value of a currency and the cost of producing it. Like the U.S. today, should this plan become a reality China could continue importing foreign goods and services while running current account deficits simply by printing more money.

On the other hand one major drawback to renminbi internationalization would be China's increased susceptibility to the inflows and outflows of international hot money. Ensuring the free movement of capital would be a critical prerequisite to the internationalization of the Chinese currency and would reduce the effectiveness of monetary and macroeconomic policies in China.

Progress towards renminbi internationalization depends not only on China's own cost-and-benefit calculation, but also on the extent to which the following conditions are being fulfilled. First, China's share in the world economy - whether in terms of gross national product (GNP) or foreign trade - needs to be fairly substantial. Second, global markets must possess sufficient confidence in the value of the renminbi. Third, China needs to have a well-functioning financial market that can freely and transparently accommodate foreign exchange trading and capital transactions, and its domestic financial market must be equally accessible to both residents and nonresidents.

The first and second conditions are gradually being fulfilled, but China has a long way to go before meeting the third condition. A particularly onerous obstacle to renminbi internationalization is a set of strict restrictions on capital transactions that is currently in place.

Some people call for accelerating the liberalization of capital transactions to facilitate renminbi internationalization, but the time is not yet ripe for that. As was apparent in the experiences of Thailand and Indonesia during the Asian currency crisis of 1997-98, it is extremely dangerous to liberalize capital transactions prematurely without paying proper attention to the vulnerability of domestic financial systems, because such an attempt could lead to inflation and subsequent collapse of a bubble.

In conclusion, China has no choice but to pursue a gradual approach to renminbi internationalization by keeping in step with its liberalization of capital transactions and the progress of its domestic financial reforms that are prerequisites to such liberalization. For the time being, the geographical scope of renminbi internationalization will be accordingly limited to countries and regions neighboring China.

April 6, 2009
  1. The internationalization of the renminbi is defined by reference to the "internationalization of the yen" in the report "Internationalization of the Yen for the 21st Century," that was compiled in 1999 by the Council on Foreign Exchange and Other Transactions, an advisory body to Japan's Ministry of Finance.
  2. For further details, see Yu Yongding, "Mĕiguó guózhài hé xióngmāo zhàiquàn [U.S. treasury bonds and panda bonds]," Policy Brief No. 08083 (December 7, 2008), Research Center for International Finance, Institute of World Economics and Politics, Chinese Academy of Social Sciences (CASS).
  3. Speech delivered by Joseph Yam, chief executive of the Hong Kong Monetary Authority, at the ceremony for the issuance of renminbi bonds by the Bank of Communications on July 16, 2008.

April 6, 2009